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Sir kaplan text book said controllable profit is usually taken after depreciation but before tax when calculating ROI
Why then do we have to add back depreciation and head office recharges?
It depends on what the manager of the division has control over.
The manager certainly does not have control over head office recharges, and probably (but it depends on the wording of the question) will not have control over non-current asset purchases and therefore over the depreciation.
Have you not watched my free lectures on this? The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
Yes I do watch your lecture but for the non current asset controlled by the head office do we have to add them the asset value controlled by the division ?
The division does not control anything. It is the manager who does or doesn’t have control.
If we are measuring the division we include these NCA’s. If we are measuring the manager then we don’t.
I mean the divisional manager not exactly the division per say! However, thanks for the correction .. This came out in the just concluded PM exams ..
Summary of the questions
The group company was using net profit and net asset value to measure ROI and RI and the targeted ROI was 15% same with % for the cost of capital . The resulted to high ROI & RI of one division and negative to the other division . The CEO concluded that division whose ROI & RI was negative was performing terrible and for that no bonus will be paid and there will be no expansion for the division .
A newly employed finance controller demanded that if this method is used to measure performance then this will be disastrous for the group !
We were asked to revised the ROI . And state two problems this RI measurement could imposed .
Non current asset and depreciation figure controlled by divisional manager figure was given separately from the NCA and depr figures controlled by the head office.
I added head office recharge plus depr to the net profit and divided by the NCA that is controlled by the divisional manager.
I noticed that both RI and ROI of the division that was performing badly was actually doing well and even supposed the targets.
Two problems :
1) disfunctional behavior if the group continues to use net profit
2) manipulation of accounting measures
3) added that it can lead to de motivation of the manager !
I hope it does good to the examiners bcos I m tired of PM exams .
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